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Productivity – Making sense of the RBA’s productivity focus, look at services inflation

• In today’s Weekly, we delve into Australia’s productivity and labour cost data. These have been the subject of the RBA’s recent focus, and may mean the level of rates needed to return inflation to target needs to be higher than previously thought (note NAB recently changed its peak RBA rate forecast to 4.60%).
• Those three points are: (1) the RBA’s assertion that their May SoMP wages forecast of 3¾-4.0% is consistent with inflation returning to target is contingent on a 1% productivity assumption; (2) the RBA’s wages profile itself has upside risks as evident by the recent award wage decision; and (3) the persistence of offshore services inflation may hint at inflation in Australia also proving sticky.
• The latest GDP figures show labour productivity has been woeful over the pandemic. GDP per hour worked was -4.5% y/y in Q1 2023. That retraced earlier gains to mean there has been virtually zero productivity growth over the pandemic with the level of GDP 7.4% above pre‑pandemic Q4 2019 levels, being almost entirely matched by an increase in hours worked which is 7.1% above pre-pandemic levels.
• That recent retracement reflects the rebound from the pandemic as firms sought to rapidly rebuild capacity amid a tight labour market (new workers are usually less productive than existing and the pandemic likely delayed or constrained investment). How enduring these effects will be is unclear. Labour productivity in the decades prior to the pandemic was relatively strong, but much of this reflected capital deepening, helped by the mining boom, rather than multifactor productivity.
• For inflation, it is unit labour costs that matter – the cost of labour adjusted for productivity – and this is running at 7.9% y/y. The key implication is that if productivity growth fails to recover, labour cost growth that would otherwise be consistent with at target inflation may not be. Due to measurement challenges, we think early evidence of this is more likely to be reflected in sticky services inflation than productivity data directly, and we think the RBA will be looking closely at this given quarterly productivity and unit labour cost growth is volatile, imperfectly measured, and released later out with a longer lag.

For the full report, see attached.